The Ethereum Merge Arrives: Narratives and Metrics
An on-chain analysis of market movements before Ethereum’s switch to a Proof-of-Stake chain
The Merge Arrives: Estimated Date
The merge has officially begun. The Bellatrix upgrade has occurred on the Beacon chain and now it is only a matter of days before the full switch from Proof-of-Work (PoW) to Proof-of-Stake (PoS) occurs. This will happen when a specific mining difficulty for a block, called Terminal Total Difficulty (TTD),takes place on the PoW chain. Once the TTD occurs, the subsequent block will be produced on the PoS chain. The exact date for this to occur is estimated from September 10th to September 20th. One estimate, referenced by the Ethereum Foundation, calculates the merge to occur between September 14th and September 15th. The graph below shows the estimated date of the TTD occurring based on the current average Tera Hashes per second (TH/s).
The merge will happen by September 15 at 12:00 UTC if the hashrate maintains an average of about 844 TH/s, but given the 30-day TH/s average shown below from IntoTheBlock’s metrics on Ethereum mining and hashrates, the expected merge date should be closer to September 14th.
Main Merge-Related Narratives
As the merge approaches, two main narratives have emerged for how traders and investors are positioning themselves based on their convictions.
- The success of the merge to the Beacon Chain
- The success of the ETHPoW fork
Merge success
Whether or not the merge will be smooth is still a large question for many. With several successful testnet merges and additional edgecase validator bugs being identified and fixed through a personal project by pseudonymous developer Banteg, the chances for a smooth merge are high. Netflows from exchanges have been negative over the last month and appear to indicate a general consensus that this will be the outcome. However, with average funding rates of perpetuals being consistently negative over the last month, it appears that many investors are hedging their bets in case the merge stalls or if it ends up being a “buy the rumor, sell the news” event. Negative funding rates could also be traders looking to remain delta neutral as they position themselves to profit off of the ETHPoW narrative explained in the next section.
ETHPow Fork
The second event that could be driving the net outflows from exchanges seen above is the PoW fork of the Ethereum Mainnet. When the fork occurs, all ETH being held in wallets can claim the ETHW token at a 1:1 ratio. This lends itself to several arbitrage opportunities and essentially an ‘airdrop’ for ETH holders. The trading possibilities that ETHW/ETH presents has led many large holders (addresses holding more than 0.1% of total supply) to accumulate over that last month and also the total number of addresses holding between 10 and 10K ETH increasing on average by 1.68%.
The demand for holding ETH has become so large that big lending protocols such as Aave and Compound have put up governance proposals to pause borrowing or increase interest rates to their max levels to deter misuse of their platforms. Furthermore, the growing demand to hold ETH in wallets appears to be causing large draw downs in ETH liquidity across AMM pools. This is highlighted by the $500M decrease in Curve’s ETH/stETH liquidity pool since August 11th.
Both of these narratives have been short-term bullish for ETH, as crypto users consolidate their positions into ETH pre-merge. Recently, ETH dominance has been flirting with its 1-year highs and has been outperforming BTC for almost two months (see chart in next section). While this has generated a lot of buzz in the crypto community, ETH has an uphill battle in front of it on the macro scale.
Zooming out to the Macro level
The merge is likely to be a momentous milestone to be remembered. However, looking at the global macro situation unfortunately paints a picture that is unfavorable for many risk-on assets. The US dollar has recently been gaining strength, which is often a bad indicator for all cryptocurrencies. Over the last three months, ETH has been substantially under performing the US dollar along with all other major indices. Additionally, with many large economies’ inflation rates at around 10%, retail investors have less disposable income to invest, indicating that any upward price movements will most likely be short-lived. Overall this could indicate that the large demand for ETH from the two merge narratives above could be short-lived and there will be an unwinding of ETH positions as investors move back to safer assets post-merge.
Final Thoughts
Short-run volatility
In the next week before the merge and shortly after, we could be in store for some high volatility. Arbitrage between the ETH/ETHW pairing will be high and could lead to high gas fees as MEV bots compete to front-run one another. Furthermore, it is possible that many of the addresses that have been consolidating into large ETH positions will unwind these holdings after the merge which could cause a large sell-off. This will potentially put at risk users that have borrowed heavily and could have a knock-on liquidation effect in the market.
Finally, the merge’s largest impact will be on miners who have invested heavily into their hardware to be able to mine ETH on the PoW. Miner netflows have seen a recent spike over the last day to a which is a 3-month high. If the ETHPoW chain does not gain sufficient traction, we could see miners selling off large amounts of their holdings as they cover the costs to close their facilities and shut down their business.
In the long-run
While fighting the macro tides will be difficult for Ethereum, there are several positive long-run outcomes in a post-merge world. The first is that moving to a PoS consensus mechanism will greatly reduce Ethereum’s overall energy consumption. When global markets start to look favorable and retail users have more disposable income to invest, energy-efficiency will be a huge marketing point for protocols building on Ethereum. This will most likely be driven by gaming protocols and NFTs being able to tout the ‘green’ aspect of the PoS chain. Furthermore, new L2s and roll-ups (and maybe even sharding?) will be well established and make it possible to perform on-chain transactions for a fraction of the cost compared to the gas war highs we have seen in the last year.
The second positive outcome of switching to PoS will be increased security and scalability potential that it will provide and has been previously covered by IntoTheBlock’s Lucas Outumuro. The increased security of a PoS chain will have additional benefits because any ETH holder who stakes their ETH with a validator will receive staking rewards. These rewards that incentivize holding more ETH alongside the estimated large decrease in total amount of ETH issued annually, will create a supply shock that could boost ETH prices in the long-term.
